Equilibrium Price and Quantity in a Competitive Market
Equilibrium
The term equilibrium means the state of balance. Equilibrium is a situation where the forces working in the opposite directions are brought to balance.
It refers to a position from where there is no tendency to change unless there is a change in the forces influencing equilibrium.
Definition of Equilibrium:
Equilibrium refers to a situation in which the quantity demanded of a commodity equals to the quantity supplied of the commodity.
It refers to the balance between opposite forces of demand and supply. In the market, balance occurs when the quantities demanded and supplied are equal.
Disequilibrium:
When the quantity demanded is not equal to the quantity supplied, we say that the market is in disequilibrium.
Equilibrium Price:
The price at which, the quantity demanded of a commodity equals to the quantity supplied is known as “equilibrium price”.
The price of a commodity in a market is determined by its demand and supply.
Equilibrium price clears the market meaning that the quantity supplied equals the quantity demanded and there is no unsold stock at this price.
Demand Side:
Demand for a good is generated by the buyers. A consumer is prepared to pay a price for a good because it possesses utility for him. The consumer would like to pay as low a price as possible.
The maximum price that a consumer will be prepared to pay for a good will be equal to its marginal utility.
Marginal utility sets the highest price limit of a commodity.
Supply Side:
Goods are supplied by producers and sellers aim at earning profit, they would like to change as high a price as possible.
There is always a minimum limit of price at which the sellers offer a good for sale.
Sellers have to incur some cost in producing a commodity. They must therefore, get at least that much price for the commodity which is equal to its marginal cost of production.
This way marginal cost is the lowest limit of the price.
The equilibrium price is the commonly agreed price which is determined by the market forces of demand and supply.
Thus, the equilibrium price is determined somewhere between its minimum limit (marginal cost of production) and maximum limit (marginal utility).
The equilibrium price, therefore, is the price at which consumers are willing to purchase the same quantity of a commodity, which producers are willing to sell.
Equilibrium Quantity :
The amount that is bought and sold at equilibrium price is called the equilibrium quantity
Market Equilibrium :
When the price equals the equilibrium price and quantity bought and sold equals the equilibrium quantity, we say that there is market equilibrium.
Determination of Equilibrium Price :
In a competitive market, a single consumer or a single seller has no influence over the market price and, therefore has no role to play in the determination of price on his own. Instead, price is determined through the interaction of the market demand and market supply..
How the forces of demand and supply operate in a market to determine an equilibrium price and quantity are illustrated by demand and supply schedule as well as demand and supply curves.
# Question : Explain how equilibrium price can be determined with the help of –
1. Demand and Supply Schedule
2. Demand and Supply Curves.
1. Demand and Supply Schedule :
The equilibrium price and quantity can be determined by using demand and supply schedule implying the law of Demand and the law of Supply
Demand and Supply Schedule for Shirts :
|
SN |
Price(Rs/Shirt) |
Quantity |
Quantity |
Market |
|
1. |
1000 |
30 |
56 |
Excess |
|
2. |
900 |
40 |
50 |
Excess |
|
3. |
800 |
45 |
45 |
Equilibrium |
|
4. |
700 |
55 |
35 |
Excess |
|
5. |
600 |
70 |
20 |
Excess |
It is clear from the given demand and supply schedule, that there is only one price i.e., Rs 800 at which quantity demanded and quantity supplied are equal. Therefore the equilibrium price is Rs 800 and equilibrium quantity is 45000 shirts.
If the market price is lower than this equilibrium price, say Rs 600 then the quantity demanded is 70000 shirts while the quantity supplied is 20000 shirts.
There is an excess demand, where the demand exceeds the quantity supplied by 50000 shirts.
This causes a shortage of shirts in the market. There is a competition among the consumers to get the good so they would begin to offer higher price.
On the other hand, the producers tend to get more profit, may begin to ask for higher price.
For either or both the reasons, prices will rise.
This rise in price happens until the market reaches the equilibrium price and equilibrium quantity and there is no shortage of good in the market.
If the market price is higher than the equilibrium price, say Rs 1000, the quantity demanded is 30 thousand while the quantity supplied is 56 thousand.
The quantity supplied exceeds the quantity demanded by 26 thousand shirts. So there is an excess supply in the market..
Due to this excess supply, the sellers tend to clear their excess stock and to attract the consumers, they begin to offer lower price for their shirts.
On the other hand, the buyers may begin to offer lower prices seeing that the producers have unsold stock of shirts.
For either or both the reasons, the prices will fall.
This fall in price happen until the market reaches at equilibrium price and quantity.
So it can be said that, at higher price there is an excess supply, which will push down the price. Similarly at lower price there is an excess demand, which will push up the price…
This happens until the price reaches the equilibrium price. At equilibrium price there would be no tendency for price to change.
Determination of Price through Demand and Supply Curve:
Determination of equilibrium price in a competitive market can also be illustrated with the help of market demand curve and market supply curve.
Determination of Equilibrium Price through Demand and Supply Curve
In the given figure X – axis expresses quantity demanded and supplied and Y- axis represents the price. DD is demand curve and SS is the supply curve. Observe that the downward sloping demand curve intersects the upward sloping supply curve at a single point. This point of intersection of demand curve and supply curve is known as Equilibrium Point.
When Market Price is Higher than Equilibrium Price:
When the quantity demanded is equal to the quantity supplied the price is said to be equilibrium price.
At equilibrium price P, the quantity demanded = the quantity supplied = PE
When the price rises to OP1, the quantity demanded will decreases from PE to P1A since many consumers who could purchase this commodity at OP price would not be able to purchase it at higher price OP1.
While the supply is increased from PE to P1B. Since the sellers tend to get more profit at higher price.
This increase in supply and decrease in demand will create excess supply.
This excess supply force the sellers to lower down the price to attract more buyers and to dispose of their surplus stock.
The price will move towards OP and hence the market price will become equal to equilibrium price.
When Market Price is Lower than Equilibrium Price:
When market price falls to OP2 the quantity demanded will increase to P2L.
Many consumers who were not able to afford this commodity at higher price, would start purchasing this commodity at the lower price.
On the other hand the amount supplied would decrease from PE to P2K. This causes an excess demand as there is quantity demanded exceeds quantity supplied.
In excess demand, there is a competition among consumers to get the commodity so they offer higher price. At the same time sellers would like to earn more profit so they ask for higher price.
The excess demand results in rise in price until the quantity supplied is equals to quantity demanded.
This condition is obtained at equilibrium price. Thus, ultimately, the equilibrium price OP prevails in the market. This denotes the situation of stable equilibrium.
A stable equilibrium is the one which, if displaced due to some small disturbance, brings forces in operation which restore the initial equilibrium position.
Thus, we can say that it is neither demand alone nor supply alone that determines the price of a product. According to Marshall :
“Just as both the upper and the lower blades of a scissor are necessary to cut a piece of cloth, similarly both the forces of demand and supply are essential to determine the price of a commodity.”
Stonier and Hague aptly commented, “The only really accurate answer to the question whether it is supply or demand which determines price is that it is both.”
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